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Darden: A Better Long-Term Play?

March 16, 2012 | About:
Darden Restaurants (DRI) is the world’s largest full service restaurant company. The company that owns chains such as Red Lobster, Olive Garden, and Long Horn Steakhouse, has a market capitalization of nearing $7 billion, and its shares trade at around $50.

People will always need to eat. And the craving to eat out in good surroundings, with good service, is likely to remain intact through thick and thin. But is that desire good enough to give strong, long lasting returns to shareholders, or is better value to be found elsewhere.

Here I compare three restaurant chains, all diverse and well managed, and assess value for investors based on comparable fundamentals.

Price to Earnings

Darden trades on a trailing price to earnings ratio of 15.23. This is lower than McDonald’s (MCD) at 18.88, and Yum! Brands at (YUM) 24.18. On a forward price to earnings basis, Darden trades at a ratio of 12.20, whilst McDonald’s trades at 15.74, and Yum! At 17.66.

Dividend and Yield

Darden offers the best yield of the three restaurant chains. At 3.5% yield, the dividend amount of $1.72 over the last year is covered 1.9 times by its earnings. McDonald’s dividend of $2.80 benefits from the same cover and yields 2.8%, though Yum!’s dividend yield of 1.7% is the lowest of the three.

Margins

Darden is weakest under this heading, with an operating margin of 9% and a profit margin of 5.8% lagging some way behind its competitors. McDonald’s is the clear winner, with its franchise based model producing an operating margin of over 30% and a profit margin of more than 20%.

Revenue and Earnings Performance

Here, again, Darden is under performing its peers. With quarterly revenue growth of just 6.10%, it falls short of McDonald’s 9.8% and even further behind Yum’s 15.4%. This said, it has produced better than expected earnings in each of its last four quarters, beating market consensus by an average of around 7%. McDonald’s and Yum! have performed more broadly in line.

Debt Position

Darden’s debt of $2.35 billion gives it a debt/ equity ratio of 137. This is of some concern, as is Yum!’s debt/ equity ratio of 173. However, restaurant chains benefit from exceptionally good cash flow and, whilst a concern, Darden’s debt position is manageable with its operating cash flow of $692 million. McDonald’s is the company with the lowest debt/ equity ratio, at 87, and its operating cash flow of $7.15 billion is easily strong enough to service its debt of $12.15 billion.

Conclusion

Darden Restaurants have a great brand name, but its lower margins and higher level of debt do cause concern. Its dividend gives shareholders a good yield, has been growing at an average of 32% over the last five years, and has been increased for 7 years straight. McDonald’s dividend, on the other hand, has increased at a healthy, more modest 25% over the last five years, though it has been increased for 35 years consecutively.

Looking at the 12 month comparison chart, Darden Restaurants shares have under performed both McDonald’s and Yum! through the past twelve months. The higher dividend yield does not compensate for this share price under performance. With the MACD line crossing below the signal, the shares look ready for a fall. Though in the longer term, Darden may return to favor, I fear that in the short term they may become unloved.

About the author:

InvestmentUnderground
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